Twenty Years of Economic Reform in India

July 25, 2011

A foreign exchange crisis in 1991 induced India to abandon decades of inward-looking socialism and adopt economic reforms that have converted the once-lumbering elephant into the latest Asian tiger, says Swaminathan Aiyar, a research fellow at the Cato Institute's Center for Global Liberty and Prosperity.

India's gross domestic product (GDP) growth rate has averaged over 8 percent in the last decade, and per capita income has shot up from $300 to $1,700 in two decades.

India is reaping a big demographic dividend just as China starts aging, so India could overtake China in growth in the next decade.

When the reforms began in 1991, critics claimed that India would suffer a "lost decade" of growth as in African countries that supposedly followed the World Bank-IMF model in the 1980s. They warned that opening up would allow multinationals to crush Indian companies, while fiscal stringency would strangle social spending and safety nets, hitting poor people and regions. All of these dire predictions proved wrong.

Booming revenue from fast growth has financed record government spending on social sectors and safety nets, even if these areas are still dogged by massive corruption and waste.

Still, poverty is down from 45.3 percent in fiscal year 1994 to 32 percent in fiscal year 2010, and the literacy rate is up from 52.2 percent to 74 percent in two decades, India's fastest improvement ever.

Several of the poorest states have doubled or tripled their growth rates since 2004, and their wage rates have risen by over 50 percent in the last three years.

However, India continues to be hampered by poor business conditions and misgovernance. India also ranks very low on ease-of-doing-business indicators. Rigid labor laws prevent Indian companies from setting up large factories for labor-intensive exports, as in China. Both governance and economic reforms are needed, but progress on the former lags far behind, is thus more urgent, and can help sustain and promote economic reform, says Aiyar.

Source: Swaminathan Aiyar, "The Elephant that Became a Tiger: 20 Years of Economic Reform in India," Cato Institute, July 20, 2011.